elasticity of demand

Elasticity and Its
Application
Chapter 5

Elasticity . . .
… is a measure of how much buyers and
sellers respond to changes in market
conditions
… allows us to analyze supply and
demand with greater precision.
Journal Question-Name 3 necessities and
3 luxuries that you would buy.

Price Elasticity of Demand
Price elasticity of demand is the
percentage change in quantity demanded
given a percent change in the price.
It is a measure of how much the quantity
demanded of a good responds to a
change in the price of that good.

Computing the Price Elasticity
of Demand
The price elasticity of demand is computed
as the percentage change in the quantity
demanded divided by the percentage
change in price.
Price Elasticity = Percentage Change in Qd
Of Demand Percentage Change in Price

Elasticity, Percentage Change
and Slope
Because the price elasticity of
demand measures how much
quantity demanded responds to
the price, it is closely related to
the slope of the demand curve.
But instead of looking at unit
change, elasticity looks at
percentage change. What do we
mean by percentage change?

Brief Assessment on
Percentages
If there are 50 tomatoes in a store and you
picked 16 of them, what percentage of the total
did you pick?
Paul used to weigh 200 lbs last year, but now he
only weighs 175 lbs. How many lbs did he lose?
What is the percent change of the loss?
What is the average of 300 and 330? What is
the midpoint?

of Demand
priceinchangePercentage
demandedquatityinchangePercentage
demandofelasticityPrice =
Example: If the price of an ice cream cone increases
from $2.00 to $2.20 and the amount you buy falls from
10 to 8 cones then your elasticity of demand would be
calculated as:
2
percent10
percent20
100
002
002202
100
10
810
==
×
−
×
−
.
)..(
)(

Computing the Price Elasticity of
Demand Using the Midpoint
Formula
The midpoint formula is preferable when
calculating the price elasticity of demand
because it gives the same answer regardless
of the direction of the change.
)/2]P)/[(PP(P
)/2]Q)/[(QQ(Q
=DemandofElasticityPrice
1212
1212
+−
+−

of Demand
Example: If the price of an ice cream cone increases
from $2.00 to $2.20 and the amount you buy falls from
10 to 8 cones the your elasticity of demand, using the
midpoint formula, would be calculated as:
32.2
5.9
22
2/)20.200.2(
)00.220.2(
2/)810(
)810(
==
+
−
+
−
περχεντ
περχεντ
)/2]P)/[(PP(P
)/2]Q)/[(QQ(Q
=DemandofElasticityPrice
1212
1212
+−
+−

Ranges of Elasticity
Inelastic Demand
Percentage change in price is greater than
percentage change in quantity demand.
Price elasticity of demand is less than one.
Elastic Demand
Percentage change in quantity demand is
greater than percentage change in price.
Price elasticity of demand is greater than one.

Perfectly Inelastic Demand
- Elasticity equals 0
Quantity
Price
4
$5
Demand
100
2. ...leaves the quantity demanded unchanged.
1. An
increase
in price...

Inelastic Demand
- Elasticity is less than 1
Quantity
Price
4
$51. A 25%
increase
in price...
Demand
10090
2. ...leads to a 10% decrease in quantity.

Unit Elastic Demand
- Elasticity equals 1
Quantity
Price
4
$51. A 25%
increase
in price...
Demand
10075

Elastic Demand
- Elasticity is greater than 1
Quantity
Price
4
$51. A 25%
increase
in price...
Demand
10050

Perfectly Elastic Demand
- Elasticity equals infinity
Quantity
Price
Demand$4
1. At any price
above $4, quantity
demanded is zero.
2. At exactly $4,
consumers will
buy any quantity.
3. At a price below $4,
quantity demanded is infinite.

Determinants of
Necessities versus Luxuries
Availability of Close Substitutes
Definition of the Market
Time Horizon

Determinants of Price
Elasticity of Demand
Demand tends to be more inelastic
If the good is a necessity.
If the time period is shorter.
The smaller the number of close substitutes.
The more broadly defined the market.

Determinants of
Demand tends to be more elastic :
if the good is a luxury.
the longer the time period.
the larger the number of close
substitutes.
the more narrowly defined the market.

Elasticity and Total Revenue
Total revenue is the amount paid by
buyers and received by sellers of a good.
Computed as the price of the good times
the quantity sold.
TR = P x Q

$4
Demand
Quantity
P
0
Price
P x Q = $400
(total revenue)
100
Q
Elasticity and Total Revenue

The Total Revenue Test for
Elasticity
INELASTIC
DEMAND
ELASTIC
DEMAND
Decrease in
Price
ELASTIC
DEMAND
INELASTIC
DEMAND
Increase in
Price
Decrease in
Total Revenue
Increase in
Total Revenue

An Example of an Inelastic
Good
Oil and Oil Prices
This video will show
the supply side issues
with getting oil out of
the ground.
Then the video will
focus on the demand
(us!) issues of using
oil.
Insert Economics Video
File 1 and play Arab Oil
clip.

Income Elasticity of Demand
Income elasticity of demand measures
how much the quantity demanded of a
good responds to a change in consumers’
income.
It is computed as the percentage change
in the quantity demanded divided by the
percentage change in income.

Computing Income Elasticity
Income Elasticity
of Demand
Percentage Change
in Quantity Demanded
Percentage Change
in Income
=

Income Elasticity
- Types of Goods -
Normal Goods
Income Elasticity is positive.
Inferior Goods
Income Elasticity is negative.
Higher income raises the quantity demanded
for normal goods but lowers the quantity
demanded for inferior goods.

Cross Price Elasticity of
Demand
Elasticity measure that looks at the
impact a change in the price of one good
has on the demand of another good.
% change in demand Q1/% change in
price of Q2.
Positive-Substitutes
Negative-Complements.

elasticity of demand

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elasticity of demand